House passes measure to extend low tax rates

WASHINGTON—Republican senators sent President Bush a $69 billion legislative package on Thursday to extend low tax rates for investors and temporarily spare millions of middle-class Americans from a creeping "alternative minimum" tax.

The legislation, along with a pending budget plan, would worsen an already grim long-term financial outlook for the federal government.

The Bush administration says the tax cuts will spur economic growth, which will yield more tax revenues. Critics say investors and the economy don't need the tax-reduction incentives and that the measure gives the vast majority of its benefits to the wealthy, relies on deceptive gimmicks to mask its true costs and will reduce revenues precisely when federal commitments for Social Security and Medicare benefits are set to explode.

Meanwhile, the House of Representatives is preparing to raise the federal debt limit for the fifth time in four years and the second time this spring, this time to nearly $10 trillion. That's almost double the $5.7 trillion gross federal debt of fiscal 2001, when President Bush took office. The Senate hasn't scheduled action on the debt limit, but many economists fear a debt crisis lies ahead that could menace the U.S. economy.

"We've got to make some very hard choices in the not too distant future. I don't think they'll be made by President Bush, but they will have to be made by whoever is going to be the next president," said Mark Zandi, chief economist for Moody's Economy.com, a consultancy.

"If you do the math, under any kind of reasonable economic assumptions the budget deficit will be 10 percent of gross domestic product 20 years from now. That's untenable. The economy will break before we get there," Zandi said.

The tax plan that Republican congressional leaders hammered out Tuesday night would reduce revenues to the Treasury by nearly $90 billion over five years but would add $21 billion in tax hikes, for a net loss of $69 billion.

It would extend until 2010 the 15 percent tax rate on capital gains and dividend income, first set in 2003. Previously, the rate was as high as 38.6 percent for dividends and 20 percent for capital gains.

The Senate approved the legislation Thursday 54-44. The House passed it 244-185 on Wednesday. Both voted largely along party lines, with most Republicans for the measure, Democrats against.

The bill also contains a one-year reprieve for roughly 15 million Americans who otherwise would pay the alternative minimum tax, a parallel income tax. It was designed to close loopholes for the rich, but because its income levels don't rise with inflation, it increasingly snares middle-income earners.

The tax package would give an average tax cut of $47 to families with incomes between $40,000 and $50,000—and $42,766 to families with more than $1 million, according to the Tax Policy Center run by the Brookings Institution and the Urban Institute, two center-left Washington research centers.

"I support a low capital-gains tax. It's hard to argue with amending the AMT. The problem is that it's not offset in any way. This failure to make choices is what is driving the budget deeper into the red," said Robert Bixby, the executive director of the Concord Coalition, a bipartisan budget-watchdog group.

Republicans have championed tax cuts since Ronald Reagan won the presidency in 1980, and they're a hallmark of Bush's presidency. But Congress hasn't matched tax cuts with spending reductions.

The result is that federal revenue has fallen since 2000 from 21 percent to 17.5 percent as a share of gross domestic product—the broadest measure of the economy. During the same period, federal spending rose from 18.4 percent to 20.8 percent of GDP. The gap is filled with borrowed money, and the debt is rising year by year.

To reach the $69 billion tax-cut total, Congress is relying in part on a gimmick that brings in revenue temporarily but loses far more revenue in future years. It would allow holders of individual retirement accounts to pay a tax now on recent investment gains. That would bring in an estimated $6.4 billion in tax revenues over 10 years. But investors then could take their account balances and convert them to Roth IRAs, in which the money could grow tax-free. By 2049, that will cost the Treasury an estimated $36 billion, according to the Tax Policy Center.

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The bill's revenue losses will deepen federal budget deficits, already projected to get phenomenally worse as the baby boom generation—the 76 million Americans who were born from 1946 to 1964—begins retiring in two years, driving up the costs of Medicare and Social Security.

"The long-run problem is so immense that what we see here is minor skirmishes compared to the nuclear wars we're going to have about the budget in 10 years," said Rudolph Penner. He's a budget expert at the Urban Institute who directed the nonpartisan Congressional Budget Office from 1983 to 1987. "Anything that reduces revenues and increases the deficit probably moves forward the date at which there will be some sort of financial crisis because of the deficit situation."

Boomers will cost Washington an estimated $4.2 trillion in current dollars to cover Social Security shortfalls from 2017 to 2040, when the program is projected to become insolvent.

Medicare's financial problems loom even larger and closer. By 2020 Medicare will take up to 25 percent of all personal income taxes—beyond the payroll taxes that now fund Medicare—to maintain promised benefits, some experts think.

Under a $2.7 trillion budget that's being crafted in the House of Representatives, the federal debt ceiling—the government's borrowing limit—would rise by $653 billion to nearly $10 trillion.

The national debt was $8.36 trillion Tuesday, according to the Treasury's Bureau of Public Debt. To finance it, the Treasury sells bonds. Foreigners held $2.2 trillion of the debt as of February; Japan with $673 billion and China $265 billion. Many economists fear that this leaves the U.S. economy dangerously beholden to foreign governments.